Once you’ve made the decision to invest your money, there are two important decisions you need to make: how much to invest and where to invest it. It’s important to understand your options as well as the risks associated with each of them.
There are three main types of investments:
- Cash Equivalent
You can invest in any or all three investment types directly or indirectly by buying mutual funds. You may also want to consider an individual retirement account (IRA) or annuity, both of which can offer tax-deferred investment savings.
When you invest in stocks, you’re buying a share of ownership in a corporation and become a shareholder. Companies sell shares of stock to raise money for start-up or growth.
There are two types of stock: common stock and preferred stock.
With common stock, shareholders have a percentage of ownership. For example, if you own one share of common stock in a company that has 100 shares, you own 1 percent of the company. Common stock shareholders also have the right to vote on issues affecting the company.
Preferred stock usually does not offer voting rights, but shareholders are generally entitled to dividends (the company’s profits distributed in cash). Preferred stockholders typically receive dividends at specified times and in predetermined amounts; common stockholders may or may not receive dividends based on company profits.
Investment returns and risks for both types of stocks vary, depending on factors such as the economy, political scene, the company's performance and other stock market factors.
When you buy bonds, you loan money to the government or to a company. Bonds are issued for a set period of time during which interest payments are made to the bondholder. The amount of these payments depends on the interest rate established by the issuer of the bond (the government or company) when the bond is issued. This is called a coupon rate. Coupon rates can be fixed or variable. At the end of the set period of time (called the maturity date), the bond issuer is required to repay the par or face value of the bond (the original loan amount).
Bonds are considered a more stable investment compared to stocks because they usually provide a steady flow of income. But because they’re more stable, their long-term return probably will be less than that of stocks. Bonds, however, can sometimes outperform a stock’s rate of return, depending on the particular stock.
Keep in mind that bonds are subject to a number of investment risks including credit risk, repayment risk and interest rate risk.
Cash equivalent investments, like passbook savings accounts, money market funds or certificates of deposit (CDs), protect your original investment and let you have access to your money.
These types of investments generally deliver a more stable rate of return. On the other hand, the rate of return (after taxes are paid) is often so low that it doesn’t keep pace with inflation. A passbook savings account, money market fund or CD may give you quick access to your cash and may provide more short-term security. However, they’re not designed for long-term investment goals like retirement.
Here are some types of cash-equivalent investment types:
- Money Market: A fund usually invested in Treasury bills, CDs and commercial paper from large established institutions. They are typically safe, liquid investments.*
- Certificate of Deposit: A fixed period, interest-bearing investment with a bank or savings & loan. An FDIC-insured CD is a low-risk investment.
- Passbook Savings: A bank account that generally provides a low, guaranteed, fixed rate of return.
- Mutual Funds: A mix of investments that may include stocks, bonds and cash-equivalents. The fund is managed by a professional money manager and has a stated objective or investment style.
More about mutual funds
Some high-growth mutual funds will consist of high-risk stocks; others
may consist of more stable stocks, as well as bonds in an attempt to beat
Always check the objective of the mutual fund and read the fund's prospectus to make sure it’s consistent with your goals. A good place to get independent information on a mutual fund, including its performance history is through Morningstar®, an independent fund rating service. Morningstar materials can be found on the internet and at your local library.
* An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although the money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in the money market. Investing may involve market risk, including possible loss of principal.